Monthly Archive for September, 2008

2 out of every 31!

Well, the nationalisation of Fannie and Freddie is obviously the news, but as a backdrop (and what I really wanted to point out), I found this amazing:

Two out of every 31 mortgages in the USA is overdue on repayments.

Formalism and synthesis of methodology

Robert Gibbons [MIT] wrote, in a 2004 essay:

When I first read Coase’s (1984: 230) description of the collected works of the old-school institutionalists – as “a mass of descriptive material waiting for a theory, or a fire” – I thought it was (a) hysterically funny and (b) surely dead-on (even though I had not read this work). Sometime later, I encountered Krugman’s (1995: 27) assertion that “Like it or not, … the influence of ideas that have not been embalmed in models soon decays.” I think my reaction to Krugman was almost as enthusiastic as my reaction to Coase, although I hope the word “embalmed” gave me at least some pause. But then I made it to Krugman’s contention that a prominent model in economic geography “was the one piece of a heterodox framework that could easily be handled with orthodox methods, and so it attracted research out of all proportion to its considerable merits” (p. 54). At this point, I stopped reading and started trying to think.

This is really important, fundamental stuff.  I’ve been interested in it for a while (e.g. my previous thoughts on “mainstream” economics and the use of mathematics in economics).  Beyond the movement of economics as a discipline towards formal (i.e. mathematical) models as a methodology, there is even a movement to certain types or styles of model.  See, for example, the summary – and the warnings given – by Olivier Blanchard [MIT] regarding methodology in his recent paper “The State of Macro“:

That there has been convergence in vision may be controversial. That there has been convergence in methodology is not: Macroeconomic articles, whether they be about theory or facts, look very similar to each other in structure, and very different from the way they did thirty years ago.

[M]uch of the work in macro in the 1960s and 1970s consisted of ignoring uncertainty, reducing problems to 2×2 differential systems, and then drawing an elegant phase diagram. There was no appealing alternative – as anybody who has spent time using Cramer’s rule on 3×3 systems knows too well. Macro was largely an art, and only a few artists did it well. Today, that technological constraint is simply gone. With the development of stochastic dynamic programming methods, and the advent of software such as Dynare – a set of programs which allows one to solve and estimate non-linear models under rational expectations – one can specify large dynamic models and solve them nearly at the touch of a button.

Today, macro-econometrics is mainly concerned with system estimation … Systems, characterized by a set of structural parameters, are typically estimated as a whole … Because of the difficulty of finding good instruments when estimating macro relations, equation-by-equation estimation has taken a back seat – probably too much of a back seat

DSGE models have become ubiquitous. Dozens of teams of researchers are involved in their construction. Nearly every central bank has one, or wants to have one. They are used to evaluate policy rules, to do conditional forecasting, or even sometimes to do actual forecasting. There is little question that they represent an impressive achievement. But they also have obvious flaws. This may be a case in which technology has run ahead of our ability to use it, or at least to use it best:

  • The mapping of structural parameters to the coefficients of the reduced form of the model is highly non linear. Near non-identification is frequent, with different sets of parameters yielding nearly the same value for the likelihood function – which is why pure maximum likelihood is nearly never used … The use of additional information, as embodied in Bayesian priors, is clearly conceptually the right approach. But, in practice, the approach has become rather formulaic and hypocritical.
  • Current theory can only deliver so much. One of the principles underlying DSGEs is that, in contrast to the previous generation of models, all dynamics must be derived from first principles. The main motivation is that only under these conditions, can welfare analysis be performed. A general characteristic of the data, however, is that the adjustment of quantities to shocks appears slower than implied by our standard benchmark models. Reconciling the theory with the data has led to a lot of unconvincing reverse engineering

    This way of proceeding is clearly wrong-headed: First, such additional assumptions should be introduced in a model only if they have independent empirical support … Second, it is clear that heterogeneity and aggregation can lead to aggregate dynamics which have little apparent relation to individual dynamics.

There are, of course and as always, more heterodox criticisms of the current synthesis of macroeconomic methodology. See, for example, the book “Post Walrasian Macroeconomics: Beyond the Dynamic Stochastic General Equilibrium Model” edited by David Colander.

I’m not sure where all of that leaves us, but it makes you think …

(Hat tip:  Tyler Cowen)

Comments are open

Potentially against my better judgement, I’ve opened up the ability of readers to leave comments.  You are no longer forced to leave a name or email address when doing so.

Update: Well, actually, I haven’t.  I can’t seem to see why it’s forcing people to log in first.

Russia, Georgia, the Caucasus

Inspired by this piece in the FT by Martin Wolf …

“I am feared; therefore I am.” This is more than a restatement of Machiavelli’s celebrated advice that, for a ruler, it “is much safer to be feared than loved”. Vladimir Putin, the latest in the long line of autocratic Russian rulers, would agree with the Italian on that. But the war in Georgia is not just a re-assertion of Machiavelli’s principles of statecraft; it is a renewal of Russian national identity. It is yet again feared. In the eyes of its rulers, therefore, it exists.

… a friend asked why, if Georgia started this whole thing, we’re necessarily viewing Russia as the bad guys.  This was my attempted reply:

First the background. The area of the Caucasus (Georgia, Azerbaijan, Armenia and bits of southern Russia) is viewed as generally important for a few reasons:

  • Geographically, it represents the land-bridge between the Caspian sea to the east and the Black sea (which connects to the Mediterranean sea through the Bosphorus (the body of water that splits Istanbul in half)).
  • Economically, it is traditionally a very important trade route between Europe and the east. In today’s world, that means that oil pipelines run through the area (the Bosphorus is the world’s busiest stretch of water for oil (the English channel is the busiest overall)).
  • Politically, it has been a focal-point of conflict for centuries, since it represented the junction of the Russian, Ottoman (Turkish) and Persian (Iranian) empires. Since World War I for sure and arguably before, the area has been seen as Russia’s “backyard” – the equivalent of Mexico and central America to the USA.
  • Militarily, the three previous reasons join to give it enormous strategic value. Commanding the Caucasus enables you to project power all over the Middle East and eastern Europe.

All of this is complicated by the fifth point:

  • Culturally, the area is enormously diverse and filled with distrust. The various national boundaries are really pretty arbitrary and only loosely represent the various ethnic, religious and linguistic groupings. Note, in particular, that the Armenians were on the receiving end of an intensely brutal killing spree by the Turks back when the Ottoman empire was coming apart. Asking whether or not to call that event genocide is a good way to get people’s tempers from perfectly calm to screaming rage in milliseconds.

On to recent history:

Given that Russia had “owned” the area for the best part of a century, it was enormously shameful to them to lose it when the Soviet Union broke up in the early Nineties. It was, in a way, the ultimate demonstration of their descent (however temporarily) into mediocrity as a world power. Imagine if not just Cuba, but the entirety of Central America had switched to Soviet-inspired communism over the space of two or three years in the late 1980s. America would have shat itself.

From the point of view of the rest of the world, though, the move to independent statehood for the three little countries represented a victory over Soviet communism and a triumph for (hopefully democratic) liberalism. That is the backdrop to the Georgia conflict. It’s Russia-at-the-core-of-the-Soviet-death-machine that is seen as the bad guy and Putin as the ex-KGB nutjob that’s pulling the strings and taking Russia back to the Bad Old Days ™.

To a certain extent, this is partially the West’s fault. When the Soviet Union fell, we didn’t do the sportsmanlike thing of offering them our hand to help them stand up. We kicked them while they were down. The Shock Therapy that we foisted on them through the voice of Jeffery Sachs might arguably have helped the Soviet satellite states like Poland and the Czech Republic, but in Russia itself it really only served to cause massive unemployment, the dismantlement of healthcare and other forms of state aid and worst of all, the pillaging of anything of economic value by the now-infamous oligarchs. On top of that, Nato simply started marching east. Russia was admitted to the G8 only grudgingly, was ignored utterly in Kosovo and has never been recognised as a grown-up on the post-Cold War stage.

Telling Georgia that they could ultimately join Nato just after Russia had finished bludgeoning Chechnya into submission with a nail-studded bat was the equivalent of deliberately spilling red wine on Russia at a fancy dinner party and then saying loudly so everyone could hear “Oh dear, and that’s your only suit. Well, I’m sure you can scrub it out in the kitchen” before turning your back on them to talk to the Austrians about how their music was always so much more inspired than that brutish Russian peasant noise.

Russia has been handing out Russian passports to anybody old enough to hold them in South Ossetia for years so they could declare that they were simply defending their citizens. They’ve been sort-of-almost occupying the region for a while anyway under the guise of peacekeeping, but that role was never recognised by the UN or any other country in the region. Formally, South Ossetia and Abkhazia are part of the sovereign nation of Georgia. Their declarations of independence were – it’s widely believed – to have been encouraged, if not actually orchestrated, by Russia in an attempted loose parallel to Kosovo.

The West in general and the USA in particular had told Georgia that they had their backs. Georgia had troops in Iraq fighting with the Americans. The Georgians, stupidly it turns out, thought they were genuine allies of America. When Georgian troops started going into South Ossetia and triggered this whole mess, it demonstrated two things. First, that the USA under the Shrub [*] administration had really, really dropped the ball in its international relations. That the Georgians managed to get the idea that the US would rush to direct war with Russia over the Caucasus really says that the State and Defence departments screwed up badly. Second, that Russia was staggeringly well prepared for the Georgian move. They just happened to have an enormous mass of troops just over the border waiting to leap to the Ossetian’s defence? No. This was a trap laid by Russia and Georgia walked into it.

[*] Little bush.